Slings and arrows of outrageous fortune were once suffered publicly by Hamlet, but now seem to reach privately some of the internecine activity between private equity firms and their capital sources. Private equity has never enjoyed the charming reputation attributed to venture capital in its early days where Kumbaya and deal sharing were tools used to launch fifty noble new disc drive companies. Private equity has had a colorful media presence formed by books such as Barbarians at the Gate and the movie, Wall Street. Each of these have myths and facts about deals on the large end of the market. Truthful or not, they were never seen as illustrative of behavior in the middle market, a competitive, albeit, much lower key arena. The keen inflow of capital and rising valuations of recent years have evolved tactics which are reminiscent of the eyebrow raising behavior seen in the above media.

The Soviet Union was known for the misleading activities of the KGB’s Office of Disinformation. Middle market private equity has taken a chapter from the Soviet manual. The first form of disinformation is to ply lending sources with misleading information about intentions to bid in an auction process or about indicated bid levels. Lenders, the yentas of the private equity world, will covertly pass along the information to curry favor with PE buyers. The next phase of the disinformation is the seller’s offering materials, as they characterize pro forma EBITDA where identifying actual EBITDA is a financial form of Where’s Waldo. The pro forma adjustments provoke angst worthy of the Princess Bride’s chess match “I know that you know that I know” scene as buyers not only know that they have identified the sellers’ earnings manipulation, but worry that others have not which leaves the bidding table uneven. The disinformation of adjustments include items like: 1) reduce CEO’s salary by half 2) addback research expenses 3) give run rate credit for stores not yet built 4) addback executive bonuses. The war of attrition becomes one of pushing back against a book of fiction while the seller hopes a chapter survives to enhance bid valuation.

Two more variants of the slings and arrows would be labeled by Chaucer as greed and wrath. Greed has taken on an audacious form in requests we have received from bankers. The first call came from a banker who represented another private equity firm which had dropped from a sale process after several months of work. The banker called asking us to hire him, which we declined. He then offered his ideas of what price would win the target. We ignored his comments, bid much less and won. He then called demanding a fee claiming he had worked for several months (for the other bidder) on the project. When we pointed out that he worked for another bidder and had offered free, poor, price advice to us, he simply became more insistent on a fee. Seeking fees for services not rendered is a new frontier. Lenders seem to have caught the same entitled greed bug. During a sale process for one of our portfolio companies, a lender called to offer us a refinancing option instead of the sale. We demurred. When we sold, the lender called demanding a fee on the theory he had created a viable insurance option to keep bidders honest. Wrath is the other variant that seems to have been created by market conditions or by watching too many episodes of the Sopranos. We have been threatened by losing bidders “We will make life very difficult for you!” in our sale processes who rely on the crazy notions that the threat would succeed and that it would not be mentioned on reference calls. We have had other situations where we were one of the two remaining bidders and the other bidder called to ask our valuation thoughts while simultaneously threatening to outbid any number we proffered. A more complex wrath strategy is where bidders have threatened financing sources with “no further business for your firm” if the lender offered a recapitalization option to Olympus as an alternative to a sale which could force higher bids. Expecting all transactions to be conducted according to Marquess of Queensberry rules would be naïve, but the market appears to have descended into more guerilla warfare than usual.